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7 Financial Facts To Know About Your Business
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Article 5: Cash Flow And Profitability
If there’s one financial principal that small business owners must understand, it’s this one: Cash flow and profitability are two totally separate things. Not understanding the difference is one of the surest ways to financial disaster.
In short: You can be profitable, but not have positive cash flow. And you can have positive cash flow, but not be profitable. The first scenario can run you out of business if you don’t have enough cash (or working capital) in the short term to pay your bills. Your business will likely survive longer under the second scenario, but you can’t stay in business indefinitely without making a profit.
It comes down to understanding the concept of “marketplace timing,” says Jim Blasingame (www.jbsba.com), the creator and award-winning host of The Small Business Advocate Show and the author of Small Business is Like a Bunch of Bananas. “If there were no taxes, if everyone paid ‘cash on the barrel’ and if we didn’t keep inventory, then marketplace timing would be eliminated and managing your business finances would be easy. But such a business is fictional.”
The first scenario (profits but no cash flow) is the most common one among small businesses. It arises when businesses have to pay their suppliers before they get paid by their customers. “The company may be profitable,” says Blasingame, “but somebody else has their cash.
“The bottom line: Don’t look at the profit on your operating statement and think you can spend that amount. And by the same logic, if you post a periodic loss, that doesn’t mean you’re out of cash.”
The second scenario (positive cash flow but no profits) is common among point-of-sale businesses (like retail and restaurants) that do receive lots of “cash on the barrel” but pay their vendors on terms. “Ever seen a restaurant open and close within 90 days?” Blasingame asks. “It probably had little to do with the food or service. Rather, the owner probably thought his or her cash was profit and spent it.
“The bottom line: Don’t look in your checkbook to see how profitable your business is.”
So, which is more important — cash flow or profit? They’re equally important for different reasons. Every business owner wants to make a profit, but every month or year may not be profitable. “You can work through an unprofitable period with well-managed cash flow,” says Blasingame. “But even a profitable business won’t last long without cash.”
Or in other words, profit may be the Queen of business, but cash is King. “The moral,” notes Blasingame, “is to manage your business for profitability, but operate it for cash flow.”
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